Oil Market Update

Oil has declined as expected and predicted in the last update, posted early in August, but has not broken down from the large formation that it has been stuck in since early 2011. Now it is showing signs that it is about to turn up and rally over the short to medium-term, although over a longer time horizon it could be severely impacted by a market crash triggered by rising interest rates.

Perhaps the most surprising thing to many is that oil has been so weak in the recent past despite the mess and mayhem in the Mid-East, which you would ordinarily expect to drive its price higher. The reason for this is of course the glut, aggravated by the poor outlook for frail economies kept on life support by money pumping. This recent weakness was presaged by the strongly bearish COT, which we paid attention to. However, the COT has moderated significantly over the past several months and the situation in the Mid-East continues to deteriorate to the point where it may very soon outweigh the other bearish factors to generate a rally. We will now look at the reasons why a rally in oil and oil shares looks imminent.

On the 8-year chart for Light Crude we can see that oil's recent drop looks rather modest in the larger scheme of things, and that it has not broken down from the Ascending Triangle pattern that has been forming for years. While Ascending Triangles are normally regarded as bullish, this one has taken so long to form that its otherwise bullish implications are viewed as having been cancelled out by the inflation that has occurred during its development. Right now it is just above the lower boundary of this Triangle, so if it going to turn higher, this is the point at which it must do so. A breakdown from the Triangle would be expected to lead to a steeper drop, initially to the support level shown, but that does not look likely over the short to medium-term.

The 6-month chart for Light Crude enables us to examine the recent downtrend in much more detail. On this chart we can see that this downtrend has been quite orderly and also that the rate of price decline has slowed significantly in recent weeks, with downside momentum dropping out, a development that frequently precedes an upside breakout. This is shown by the recovering MACD indicator at the bottom of the chart and in particular by the now positive MACD histogram (blue bars). After yesterday's improvement oil looks ready to break out of this downtrend, although it could back off again first.

On its latest COT chart, we can see that after being strongly bearish back last June and July with high Commercial short and Large Spec long positions as the downtrend got started, it has now moderated substantially after many weeks of easing to the point that, although not emphatically bullish, there is certainly room for a significant rally to develop.

Click on the chart above to pop up a larger clearer version.

The 1-year chart for Light Crude above is included to enable direct comparison with the COT chart above, which goes back about a year. As we can see the COT is now showing readings comparable to those that preceded the substantial rallies that followed the lows of last November and January.

What about oil stocks? – overall it has to be said that the long-term oil stocks index charts still look good, although the convergence of the long-term uptrend channel shown on the 8-year chart for the XOI oil stocks index below reminds us not to forget the lurking general crash risk. In the last update we observed that the index was still close to the top of this channel, and thus vulnerable to further weakness, which is what we saw. Now it has reacted back quite steeply to a still rising 200-day moving average, which promises an immediate reversal to the upside, especially given the continuing deterioration in the Mid-East situation.

On the 6-month chart for the XOI oil stocks index we can see that it has reacted back really rather steeply this month, which is somewhat surprising given the increasingly grave situation in the Mid-East. However, there are a number of signs that it is about to reverse to the upside. One is that whenever an index (or stock or whatever) reacts back from a long way above its rising 200-day moving average to make first contact with it, it normally generates a recovery, especially if at the same time it is way below its 50-day moving average and deeply oversold, and at a support level, which this is. All this creates a high degree of compression – at this point the entire reaction from the June high must be considered a counter trend move, which means that there is scope for a big rally to develop from here, and yesterday's action in the index looked quite bullish.

The Crude Oil hedgers position chart shown below, which is a form of COT chart that goes back much further than the one shown above, reveals that overall the COT position for oil still has a bearish tone, although it is greatly improved on several months ago. This is nowhere near as bullish as the hedgers charts for Natural Gas, Gold and Silver, which we just looked at, which kind of implies that oil may “come along for the ride” as part of a broad based commodities rally soon, probably as the now hugely overbought dollar reacts back.

Click on the chart to pop up a larger clearer version.

Chart courtesy of www.sentimentrader.com

The Crude Oil Optix or optimism chart is in middling ground but heading towards being bullish, in marked contrast to a few months ago, when it was extremely bearish – so there is certainly room for a rally to get going in oil soon.

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